China's Peer-To-Peer Lending Bubble Bursts As Up To 90% Of Companies Expected To Default

When it comes to the topic of China's epic credit bubble (which continues to get worse as bad debt accumulates ever higher), we have beaten that particular dead horse again and again and again and, most notably, again. However, since in China the concept of independent bank is non-existent, and as all major financial institutions are implicitly government backed, by the time the "big" bubble bursts, it will be time to hunker down in bunkers and pray (why? Because while the Fed creates $1 trillion in reserves each year, and dropping post taper, China is responsible for $3.6 trillion in loan creation annually - yank that and it's game over for a world in which "growth" is not more than debt creation). But just because the big banks can continue to ignore reality with the backing of the fastest marginally growing economy in the world (inasmuch as building empty cities can be considered growth), the same luxury is not afforded to China's smaller lender, such as its peer-to-peer industry.

Granted, in the grand scheme of things P2P in China is small, although in recent years, as a key part of shadow banking, it has been growing at an unprecedented pace: according to research published last year by Celent consultancy, the country’s P2P lending market grew from $30m in 2009 to $940m in 2012 and is on track to reach $7.8bn by 2015. Here's the problem: it won't. In fact, China's P2P lending boom just went bust because as the FT reports, "dozens of the P2P lending websites that sprang up in recent years have shut as borrowers default on loans. The biggest companies are unscathed so far, but the rapid collapse of smaller rivals highlights the mounting difficulties in the Chinese micro-lending industry as economic growth slows and monetary conditions tighten... Of the nearly 1,000 P2P companies operating in China, 58 went bankrupt in the final quarter of last year, according to Online Lending House, a web portal that tracks the industry. Several more had already run into trouble this year, it added."

And it's only going to get worse:

"The main reasons are the intense competition in the P2P industry, the liquidity squeeze at the end of the year and a loss of faith by investors," said Xu Hongwei, chief executive of Online Lending House. He estimated that 80 or 90 per cent of the country’s P2P companies might go bust.

Oops. None of this is unexpected: after the Chinese banking system nearly collapsed in June, following an explosion in overnight lending rates on just the mere threat of tapering of liquidity by the PBOC (since repeated several times with comparable results), it was inevitable that there would be unexpected consequences somewhere.

That somewhere is manifesting itself in the one industry that was supposed to gradually alleviate the lending burden for the SOEs.

People in the industry had hoped that P2P lenders would fill a hole in China’s financial system by helping small businesses obtain funding and by giving investors higher returns than they can obtain from banks.

While proponents believe that will still eventually prove to be the case, many believe the industry has expanded too quickly and with insufficient oversight.

“A lot of P2Ps have blindly copied each other and they don’t have a business plan that is robust enough to react to market changes. They’ve just focused on sales, scale and bragging to each other,” said Roger Ying, founder of Pandai, one of the websites that is still active.

Wangying Tianxia, a Shenzhen-based lender, was one of the biggest P2Ps to fail, according to the Shanghai Securities News, an official newspaper. Between its founding in March last year to its failure in October, Rmb780m ($129m) of loans were disbursed via its platform.

A second China-wide cash crunch at the end of December heaped more pressure on P2P lenders. Fuhao Venture and Guangrong Loans posted notices on their websites in the first week of the new year warning investors that loan repayment might be delayed.

So, condolences to China's P2P business model: if it is any consolation, you are merely the first of many debt-related dominoes to tumble in China.

But while the Chinese government has already thrown in the flag on P2P - after all at just over a $1 billion in notional how big can the damage be - it is desperately scrambling to give the impression that all is well in the other, much more prominent areas of its credit bubble. Which is why the WSJ reports that "China's government is gearing up for a spike in nonperforming loans, endorsing a range of options to clean up the banks and experimenting with ways for lenders to squeeze value from debts gone bad.

Write-offs have multiplied in recent months. Over-the-counter asset exchanges have sprung up as a way for banks to find buyers for collateral seized from defaulting borrowers and for bad loans they want to spin off. Provinces have started setting up their own "bad banks," state-owned institutions that can take over nonperforming loans that threaten banks' ability to continue lending.

"In recent years, Chinese banks have been exploring new avenues to resolve their bad loans," said Bank of Tianjin, which is based in northeastern China. The lender recently listed more than 150 loans for sale on a local exchange. "We will continue to recover, write off, spin off and use other avenues in order to resolve bad loans," it said.

China's banks reported 563.6 billion yuan ($93.15 billion) of nonperforming loans at the end of September. That is up 38% from 407.8 billion yuan, the low point in recent years, two years earlier.

Amusingly, just like in the US, where nobody dares to fight the Fed, in China the sentiment is that nothing can possibly go wrong at a level that impairs the entire nation: "Analysts think it is unlikely that Beijing would let major banks go bust. Still, investors suspect the cost of a cleanup could be a sizable economic burden and could become even greater if growth continues to slow."

Good luck with that, here's why:

"The last time Beijing confronted bad-loan problems, in 1999 and 2000, the sums involved had crippled the banking system. Banks became far less able to make new loans, forcing the government to take action. Some 1.3 trillion yuan of bad debt was spun off the books of the biggest state banks and swept into four purpose-built bad banks.

This time, to avoid a costly bailout in the future, the government is pushing the banks to clean up their mess early. It is giving them new tools to do so: the exchanges to sell bad assets, provincial-level bad banks and permission to raise fresh capital using hybrid securities, complex products that combine aspects of debt and equity."

One small problem: sell them to who? After all China is a closed system, and the US hedge funds have their hands full will pretending Spain and Greece are recovering and sending their stock markets to the moon because of the endless stream of lies emanating from the government data aparatus, all of it made up.

A potential constraint on the bad-debt cleanup is the inexperience of buyers at pricing and dealing with distressed debt, never a significant asset class in China. Finding buyers for a failed factory or commercial property seized as collateral can be difficult, particularly in cities with weaker economies.

"There's an immature market for collateral. So the banks' capacity to resolve loans is more determined by the market than their own abilities," said Simon Gleave, regional head of finance services at KPMG China.

Analysts see the bad-loan problem as a growing issue. Although figures as of the end of September indicate bad debt represents only about 1% of total loans in

China's banking system, a range of major industries are plagued with overcapacity and local governments are struggling to repay money borrowed to fund a construction binge. Investors broadly believe the actual bad-loan figure is much higher. The share prices of Chinese banks listed in Hong Kong have fallen, to trade below their book value.

And while all of the above is accurate, here is the biggest constraint: it is shown as the blue line in the chart below:

Applying a realistic, not made up bad debt percentage, somewhere in the 10% ballpark, and one gets a total bad debt number for China of... $2.5 trillion, and rising at a pace of $400 billion per year.